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Market watchers have assumed that small asset managers would be hardest hit when the credit cycle ends and it becomes harder to sell bonds to meet redemptions from investors or to raise cash for other reasons.

But J.P. Morgan Asset Management is arguing in a new study for the firm’s clients that it is the largest firms that are at greatest risk of not being able to sell credit, such as high-yield bonds.

That’s because larger, more sophisticated investors will likely have more private assets in their portfolios that can’t be sold — and more public securities that need to be sold in a system that isn’t functioning well.

“The conventional wisdom is that if you are big and sophisticated, you’ll be okay,” said John Bilton, head of global multi-asset strategy at J.P. Morgan Asset Management. “But the reverse is true. Larger institutions may have to move a lot of volume through what will be narrowing pipes.”

Asset managers and institutional investors have raised concerns about what will happen during the next period of extreme market stress, now that banks have stepped back from making markets and trading fixed income in the decade since the financial crisis. Smaller investors have been particularly worried, as they don’t have as much clout with dealers as their larger counterparts. Until recently, there have been few periods of volatility since 2008, and the markets haven’t been tested.

“If you are a relatively small investor, it doesn’t matter than much; you’ll probably get your trade done,” said Bilton in a phone interview. But larger investors, including J.P. Morgan, may only be able to complete transactions over weeks, not days, increasing the risk that markets will move down further, he said.

Bilton said the realization came out of conversations with clients about being able to stay invested in their growing portfolios of illiquid assets such as private equity and real estate by selling publicly traded securities if needed.

“One significant conclusion from our analysis is that while larger and more sophisticated investors have a greater propensity to take on private market illiquidity risk, the ability to absorb unexpected public market illiquidity episodes decreases as fund size grows,” wrote the authors of the report, entitled “Managing Illiquidity Risk Across Public and Private Markets.”

“Unlike so many issues in investing and finance, there is no economy of scale for managing public market illiquidity,” they continued. “Indeed, there are diseconomies of scale.”

J.P. Morgan Asset Management is discussing with portfolio managers how to deal with the issues, including making sure they are being paid to take on the increased illiquidity risk of securities like high yield.

Institutional investors have generally demanded a premium of three to five percent to compensate for taking on the risk of not being able to sell at all times. In public markets, though, most investors haven’t demanded any premium for the growing risk of illiquidity. That needs to change, Bilton said.

Mutual funds that can face redemption requests from shareholders at any time face the most risk, while sovereign wealth funds and other institutions that don’t have daily cash needs will likely be able to weather a downturn with few changes, according to J.P. Morgan. In addition, pension funds may have bigger cash needs than they think, especially if they are in negative cash flows, such as closed plans.

Smaller firms may be the liquidity backstop — buying when no one else will, a role historically played by investment banks, sovereign wealth funds and central banks.

“Smaller investors are nimbler but should be mindful of the constraints that public and private market illiquidity place on larger investors and how this might distort market pricing at times of stress,” according to the report.

"The risk of a downturn is rising. We have to be mindful that the illiquidity problem has increased. The bigger you are, the more you have to plan,” said Bilton.